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By Christine Benz and Shannon Zimmerman | 02-10-2014 01:00 PM

A Closer Look at Two Medalist Balanced Funds

Investors tend to capture more available returns in balanced funds due to a smoother ride.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Although combination stock/bond funds rarely jump to the top of the charts, they tend to be easy to own. Joining me to discuss this topic is associate director of fund analysis Shannon Zimmerman.

Shannon, thank you so much for being here.

Shannon Zimmerman: Always good to be with you, Christine.

Benz: Shannon, you brought a couple of funds that you want to delve into a little more deeply. But first let's state the case for allocation type funds--funds that invest in both stocks and bonds. Why do you think the category can be worth a look, even for people who aren't just starting out with their investment portfolios, which is often the type of investor who looks at this type of product?

Zimmerman: Some of the funds are quite unusual and sophisticated investors would want to give them a look as well. Lazy investors will want to give these funds a look, too, or at least the category. It's not necessary to use them in this way, of course, and probably for most people who have them in their portfolio, it's one of many funds. But for folks who are looking for a one-stop shopping solution for both equity exposure and fixed-income exposure, it offers that in terms of the asset allocation.

Beyond that, though, you have to look carefully at what the portfolios hold, not just now in the currently disclosed portfolio, but what they've held historically. The two funds that we are going to talk about are quite different in what their orientation has been toward the fixed-income side of the allocation.

Benz: Let's dig into this "easy-to-own" issue as well. We've got these investor return statistics that marry a fund's total return with the cash flows in and out of the fund. What do we see when we look at that data in terms of how target-date fund investors have done, as well as how investors in more traditional balanced funds have done.

Zimmerman: If you take a step back and you look at the fund universe broadly, investors have not done a very good job of using volatile equity funds very well at all. Typically, you see a big gap for the most volatile funds between what the fund has actually delivered and what investors have gained.

Benz: So what happens is that investors chase that performance, and they get there late.

Zimmerman: Right.

Benz: In time to see maybe performance fall off.

Zimmerman: A fund I have mentioned before, Fidelity Leveraged Company Stock, which I cover, and over the last decade I think the annualized total return is about 11%, and the typical investor less than 4%, which is heartbreaking because the fund has done well, but the investor hasn't done nearly as well.

So, why does it happen? It has to do with volatility. People are reading their quarterly performance reports, and they get the willies whenever their fund is not on the rise. That's modulated with the asset allocation funds. Because it has the equity sleeve and it has the fixed-income sleeve.

So, even though correlations have gotten tighter in recent years, that still does help to give a muted volatility profile. Consistent with the research that's found that investors don't use volatile funds very well, they do tend to use funds with a smoother risk profile much better, and that's certainly the case with … the majority of allocation funds relative to just straight-up equity funds.

Benz: The first fund you want to talk about is from a shop that you cover, it's Oakmark Equity & Income. I associate Oakmark with being a topnotch equity manager, bonds not so much. But you still think it's a good pick.

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